Debunking One of the Worst Ideas in Economics (The Naked Economist)

Yahoo! ^ | May 3, 2006 | Charles Wheelan, Ph.D

[TheDon]

In this column, I'm focusing on bad economics. In fact, I'm going to write about what I consider to be the two worst economic ideas -- or at least ideas that pass as economics, though both have been thoroughly repudiated by nearly all credible thinkers.

....

For the sake of political balance, I'll skewer a favorite of the right in this column, and then a favorite of the left in my next piece.

The Laffer Curve

Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves. (In one of life's great coincidences, he first sketched a graph of this idea on Dick Cheney's cocktail napkin.) If the government cuts taxes, then Uncle Sam gets a smaller cut of all economic activity -- but reducing taxes also generates new economic activity. Laffer reasoned that, under some circumstances, a tax cut would stimulate so much new economic activity that the government would end up with more in its coffers -- by taking a smaller slice of a much larger pie.

.....

Think about a simple numerical example: Assume you've got a $10 trillion economy and an average tax rate of 30 percent. So the government takes $3 trillion.

Let's cut the average tax rate to 25 percent and, for the sake of example, assume that it generates $1 trillion in new economic growth (a Herculean assumption, by the way). So now, what does Uncle Sam get? One quarter of $11 trillion is only $2.75 trillion. The economy grows, government revenues shrink.

....

[facedown]

Another theoretician unencumbered by real-life results.

[Jibaholic]

Two points:

1. The marginal tax rate was 70% under Carter. The laffer curve certainly applied when cutting taxes then.
2. Even if the revenues of cutting lower marginal rates do not offset, the economy still grows. That means more jobs.

[rhombus]

State income tax revenue runneth over

http://www.freerepublic.com/focus/f-news/1625981/posts

[Excellence]

Shouldn't this be about a governments "right" to seize the private property of its citizens?

[the invisib1e hand]

...assume...

there's the rub...

[Ramius]

$1 trillion in new economic growth (a Herculean assumption, by the way).

Ten percent growth in an economy is "Herculean"??

I think I've spotted his problem...

[On the Road to Serfdom]

If Laffer were right, lower taxes would never require any spending sacrifice.

Wow, what a bold face lie.

[G-Bear]

This goof looks at it as a simple mathematical equation.

He takes no account of entrepeneurism.

Besides which, when observable reality contradicts your theory, you should change your theory, and not conclude that reality is wrong.

[edsheppa]

According to The Economist -- my former employer and no bastion of left-wing thought --

Right.

[Logophile]

The economy grows, government revenues shrink.

That sounds good to me.

[staytrue]

The economy grows, government revenues shrink.

And a GROWING ECONOMY IS BAD ?

It seems to me the way to go is to cut govt. spending, cut taxes and sit back and watch the economy go roaring ahead and everyone gets rich.

[MHGinTN]

Do you know what you get by lots of assuming?... Full of donkey meat.

[r9etb]

The problem with the article is that it doesn't actually provide any actual data on the effects of changes in the marginal tax rate, even though such data are presumably available.

If I'm not mistaken, I believe that federal revenues increased (as predicted) after marginal rate decreases.

So Wheelan's hypothesis/complaint seems to have a serious empirical problem.

[staytrue]

It seems to me that with a growing economy, govt spending should shrink because of the lesser spending on welfare.

The real question is why this does not happen.

[cpdiii]

0% tax = no revenue
100% tax = no revenue as people would not work.

What the author fails to address is what is the top of the Laffer Curve where tax revenues are max. He fails to address this because he believes in high taxes and a ever expansive government. His article is pure BRAVO SIERRA!

If my memory is correct the Laffer curve top is around 37%. This is for all taxes combined i.e. state, local, federal, social security etc. Someone correct me if I am wrong on the percentage.

[ConservativeMind]

This column should give you a hint of why economics is called the dismal science -- it's all about tradeoffs.

That isn't necessarily true of the science of economics and it is especially not true of real life.

Economics is not a mere zero-sum game. In other words, if one person wins, the other MUST lose something. In fact, I don't recall any economics professors I've had that thought zero-sum reflected reality; instead, it could only be used to illustrate simple relationships.

There are times that a synergy is created; in effect, both parties get something much more than they could realize apart. One example many have is that of a good marriage.

On another note:

His attempt at debunking the use of the Laffer Curve is pretty lame. Even he admits the Curve effect is real (and then provides no basis for a 'place' on the curve taxes ought to be). The Laffer Curve is real and can show how taxes prevent a greater good from being achieved by all.

I agree spending must be cut, but not because the Laffer Curve theory 'fails'.

[lepton]

Let me be perfectly clear: I'm not arguing that tax cuts are bad. I'm simply pointing out that we can't pretend that tax cuts won't require reductions on the spending side to balance the budget. In fact, you can disregard every other argument in this column and think about one thing: If Laffer were right, lower taxes would never require any spending sacrifice. We could pay a mere one percent of our income in taxes and still fund all of our government spending -- and maybe more! Do you think that's really possible?

This section demonstrates that he is not simply wrong, but is utterly clueless in what the Laffer curve says/is. What is his Ph.D. in? Art Education?

[youngjim]

So why does Laffer's sketch on Dick Cheney's cocktail napkin rank near the top of my list of bad economic ideas? Because, when applied to the U.S., it's intellectually dishonest. The Laffer Curve offers the false promise that we can cut taxes without making any sacrifice on the spending side, and that's simply not true. It's the economic equivalent of arguing that you can lose weight by eating more.

Between total confiscation and no taxes the law of diminishing returns dictates that govt revenues will indeed go down if taxes are cut beyond some level. The writer projects his own intellectually dishonesty by omitting mention that in a discussion of the curve, i.e., it's not the Laffer straight line.

Ironic that this guy wrote this column for 'yahoo.'

[coon2000]

The Laffer curve does not indicate that always lowering taxes increases revenue to the government. There is a point at which revenues are maximized, going below that point will mean less revenues to the government. We need to find that point, and at the same time reduce government spending. As spending falls we can further reduce the tax burden on the citizens who pay taxes.

[Wurlitzer]

Well there is a much better explanation of the curve that has NO political bias.

If the government sets the tax rate at 0% they will have no income but the private sector will have more money.

If the government sets the tax rate at 100% they will kill the private sector and there will be nothing to tax so again the governments income = $0.

Somewhere in between 0% and 100% is the sweet spot where both the private sector and public sector reap the greatest income and depending upon the starting point YES YOU CAN LOWER TAXES AND INCREASE REVENUE but only and this is the big point only if you currently taxing at a rate above the sweet spot.

The trick is to determine the sweet spot. Enter the politicians and they will make sure it is never found.

[nightdriver]

"The economy grows, government revenues shrink."

Uh, no, Chuck. That's not what happened.

"That's basically what happened with the large Reagan and George W. Bush tax cuts, both of which were followed by large budget deficits."

In spite of the PhD after Chuck Wheelan's name, he is sadly mistaken both about the nature of taxation and history.

Under Reagan's tax cut, the TAX REVENUES, not just the economic activity, increased, not decreased. In fact, REVENUES went from about $500 billion to close to $1,000 billion just because the tax pressure on the brake pedal of the economic vehicle was eased off a bit.

Unfortunately, the irresponsible, spendthrift congress proved to be up to the task of overspending even that unusually large increase.

Poor Chuck. All that study to get a PhD and he still has no concept of the dynamics of economics.

[ConservativeMind]

It's funny. This week, John Kenneth Galbraith (Canada's "Keynes" according to the Toronto Sun) died.

Keynes was the one that popularized the "zero-sum" game idea. It has been disproven again and again.

I had the great opportunity to correct a graduate level economics professor in class before 50 other students. He had to publicly acknowledge that many of Keynes' points were now invalidated, but what he was wanting to use in class that day was not.

Accurate economics theory comes from the University of Chicago. Read it and weep, liberals.

[MaDeuce]

"If Laffer were right, lower taxes would never require any spending sacrifice. We could pay a mere one percent of our income in taxes and still fund all of our government spending -- and maybe more! Do you think that's really possible?" Why, yes I do really think it is possible! If the gov't was funding programs that the gov't was AUTHORIZED TO FUND UNDER THE CONSTITUTION, then a 1% tax should be fine ... don't you all agree?

[hosepipe]

How about givernment rolling back ALL energy taxes.. Taxes on energy raise the price of literally everything.. That would give "the economy" growth rate unequaled in modern times..

There are taxes on ALL energy production and taxes on the distribution of it.. The givernment does literally nothing for these taxes.. it adds no thing.. These taxes are merely parasitical on the host(the people)..

STOP all federal, State, County, and local taxes on energy.. like on MILK... Energy is the milk of any economy.. I say that just as starters.. because there are far more parasitcal things givernment does than tax energy.. but IT WOULD BE A START IN THE RIGHT DIRECTION..

[GEC]

average...marginal

This guy needs to go back to high school and take calculus again.

What a maroon.

[Yo-Yo]

Think about a simple numerical example: Assume you've got a $10 trillion economy and an average tax rate of 30 percent. So the government takes $3 trillion.

Let's cut the average tax rate to 25 percent and, for the sake of example, assume that it generates $1 trillion in new economic growth (a Herculean assumption, by the way). So now, what does Uncle Sam get? One quarter of $11 trillion is only $2.75 trillion. The economy grows, government revenues shrink.

And in year 2? In example 1 the Government takes in $3 trillion from a stagnent economy. In example 2, the government takes in one quarter of $12.1 trillion, or $3.025 trillion.

Year 3? Example one says the Govenment takes in $3 trillion from a stagnent $10 trillion economy, while in example 2 the government takes in 25% of a $13.31 trillion economy, or $3.3275 trillion.

Year 4? Year 5? Moron. (Wheelan, not The Don.)

[beancounter13]

For a Ph.D., he disappoints me. First of all, he treats the Laffer Curve as a linear reality. Anybody can pick a point below the "curve" and say is proves the curve doesn't work. His example is merely that.

Secondly, he does not account for cumulative impact. One could take his very example, assume tax rates are cut from 30% to 28%, and add a 5% annual growth rate over five years. Such a calculation shows tax revenue increasing from $15T to $16.25T over those five years even though tax rates were cut.

[trashcanbred]

Let's cut the average tax rate to 25 percent and, for the sake of example, assume that it generates $1 trillion in new economic growth (a Herculean assumption, by the way). So now, what does Uncle Sam get? One quarter of $11 trillion is only $2.75 trillion. The economy grows, government revenues shrink.

Actually it is not a "Herculean assumption" at all. Cutting taxes, like lowering interest rates, has a much larger effect than the simple amount that it is lowered.

[Dahoser]

There are two major things he conveniently omitted (at least):

1. The ability to take non-taxable compensation. A person faced with a high marginal rate in taxable income will opt for a much lower taxable income with a large non-taxable component to compensate. However, this person will be inclined to take more income as taxable if the marginal rate comes down substantially because that is a better deal, and more income as taxable means more tax revenue.
2. Deficits don't come from too little revenue. The criminal class, be it RAT-controlled or Republican-controlled, simply cannot stop spending money. You could confiscate all the wealth in the world and these clymers would still run a deficit. Recall that Gramm-Rudman-Hollings set a deficit target not a spending target. A deficit target means you spend everything you take in plus the deficit; a spending target means you fit what you have to spend to the target. It's no small wonder that they chose a deficit target.

[USFRIENDINVICTORIA]

"For the sake of political balance, I'll skewer a favorite of the right in this column, and then a favorite of the left in my next piece."

What will the next column be about? He'll probably have a hard time choosing -- there are so many "worst" economic ideas beloved by the left.

[Larry Lucido]

Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves

Laffer said no such thing. And according to the Lucido Curve, there is an optimum amount of useful information available in a single article, after which continued reading diminishes intelligence, so I figured I could stop reading right there.

[Mase]

Wheelan holds a Ph.D. in public policy from the University of Chicago, a Master’s in Public Affairs from Princeton University, and a B.A. from Dartmouth College

The term "uniquely unqualified" comes to mind.

[Larry Lucido]

"optimum amount" should be "optimal amount"

[staytrue]

he does not account for cumulative impact.

excellent posts 27 and 28

I did not account for it either. You learn something new everyday.

[HardStarboard]

>>>Another theoretician unencumbered by real-life results. <<<

He ignores he very human trait of attempting to avoid paying taxes when they are high, and being more willing to pay up when taxes are more reasonable.

Of course he's an "economist", so he is unable to fathom anything that can't be reduced to a graph.

[voteconstitutionparty]

It goes on to say...

"That's basically what happened with the large Reagan and George W. Bush tax cuts, both of which were followed by large budget deficits. Yes, spending has a lot to do with that, but the bottom line is unequivocal: In both cases, government revenue was lower than it would have been without the tax cuts."

[Logophile]

The Laffer curve does not indicate that always lowering taxes increases revenue to the government. There is a point at which revenues are maximized, going below that point will mean less revenues to the government. We need to find that point, and at the same time reduce government spending. As spending falls we can further reduce the tax burden on the citizens who pay taxes.

You have described the Laffer curve as I understand it.

I agree with you about the need to reduce government spending, especially government spending on unconstitutional functions. However, I am less concerned about finding the point that maximizes government revenues. More important to me is to maximize the wealth of the private sector.

[Cruising Speed]

A Ph.D. and he can't figure out the Laffer curve. What's his degree in...finger painting?

[facedown]

For a Ph.D., he disappoints me.

I had always heard that this stands for "piled higher and deeper". My wife informs me that the new translation is "post hole digger". I should know, I are one.

[Marxbites]

This guy talks on NPR - nuff said.

And uh, what about the unforseen extra $100 billion in revenues last year?

Although cutting the FREAKIN vote buying spending should be job one.

Vote em all out but Paul, Coburn, Pence and very few others and lets start with a clean slate who knows their reelections depend on shrinking the beast and it's burdens.

[Marxbites]

Like a Clinton Bravo Juliette? Indeed!

[Marxbites]

HELL YES!

[stockstrader]

As if anyone can tell the precise rate of tax that maximizes revenue for the government. Even he admits that lower rates DO stimulate growth--and more tax revenue (albeit not 100% of the rate cuts).

Since that 'perfect' rate can NEVER be precisely determined--I'd much, much, MUCH prefer erring on the side of LESS tax revenue for the government, than more.

[RayStacy]

Let's cut the average tax rate to 25 percent and, for the sake of example, assume that it generates $1 trillion in new economic growth (a Herculean assumption, by the way). So now, what does Uncle Sam get? One quarter of $11 trillion is only $2.75 trillion. The economy grows, government revenues shrink.


That's basically what happened with the large Reagan and George W. Bush tax cuts, both of which were followed by large budget deficits. Yes, spending has a lot to do with that, but the bottom line is unequivocal: In both cases, government revenue was lower than it would have been without the tax cuts.

Okay, somebody help me out here. I know for a fact (because I've looked it up in the US Stat. Abstract several times in order to intellectually rape liberal dumb asses) that under Reagan, gov't income MORE THAN DOUBLED after the tax cuts. I don't remember if that was in real or nominal dollars, but it was still good. I also know that for every new dollar that came in, the filthy whores in DC spent something like 1.5 dollars -- hence the huge deficit. Is my memory totally wrong here?

[rwfok]

The Real Reagan Economic Record: Responsible and Successful Fiscal Policy:

http://www.heritage.org/Research/Taxes/BG1414.cfm

[norwaypinesavage]

Hey, Mommy. Why is that guy not wearing any clothes?

[gondramB]

>>1. The marginal tax rate was 70% under Carter. The laffer curve certainly applied when cutting taxes then.
2. Even if the revenues of cutting lower marginal rates do not offset, the economy still grows. That means more jobs.<<

Its got to work at least one time before you can say it ever applies.

[longtermmemmory]

I knew only one man who really understood ecconomics and had an ecconomics degree...


graduate eureka college


Ronald Wilson Reagan


This author person deserves to be a poor ecconomist.

[longtermmemmory]

He is a socialist

The glass is not half empty or half full, he thinks the glass is too big.


The US ecconomy is not a zero sum game.